Approaches to Creating Rental Housing

Approaches to Creating Rental Housing

There are many ways to create affordable rental housing, and jurisdictions can tailor HOME and CDBG funds to address local housing market conditions. For instance:

  • In some communities, there is a surplus of available standard rental housing but it is not affordable to low-income households. In these communities, the right approach might be to acquire these existing units, lower the their cost, and rent them to low-income households.
  • In communities with a sufficient supply of standard housing, it might make sense to provide assistance to the tenants, rather than to the owners. This is known as “tenant-based rental assistance,” or TBRA.
  • In other communities where rental housing exists, but it is in poor condition, an effective rental housing program might focus on rehabilitating these existing structures, or on acquiring and rehabilitating them.
  • In communities that lack a supply of available housing, and those that are characterized by low vacancy rates and high rental prices, new construction might be the best way to create affordable rental housing.

This section describes each of these approaches and their applicability to HOME or CDBG programs.

Acquisition

An acquisition program involves purchasing existing rental units within the community and then lowering their rents to make them affordable to low-income households. Usually, this is accomplished by directly subsidizing the purchase of the units so that the owner’s ongoing financing costs are reasonable and therefore, he or she can afford to offer lower rents.

Example: Rental Acquisition Program

The City of Westwyn found that it had a number of modest rental developments that were in standard condition, but whose rents were generally out of reach for low-income households. It worked with a local nonprofit to purchase the 20-unit Westside Apartments for a total price of $1,000,000. At that purchase price and with a standard market rate loan, the nonprofit would have had debt service that required rents at $700 per month in order to make ends meet. In order to lower the rents to the $600 and $400 high and low HOME rents, the PJ provided the nonprofit with a deferred, forgivable payment loan of $300,000. Since the nonprofit did not need to make debt service payments on this loan and only needed to borrow $700,000, it could afford to offer rents at the HOME rent levels.

The benefit of using an acquisition approach to developing affordable rental housing is that it can be very cost effective since no construction is needed. It can also be used to further mixed-income housing goals. For example, using HOME funds, a PJ could assist a developer who was purchasing a 50-unit building. The HOME funds could be targeted at five of the total units, with financing capped at the maximum per unit subsidy limits. These five units would carry the HOME restrictions related to affordability, income, unit quality, etc. The remaining 45 units could rent to moderate- or upper-income people. Note: assuming that the low and moderate-income housing national objective is being used, acquisition would work with CDBG funds only if low-and moderate-income persons occupy at least 51 percent of the units.

The acquisition approach to rental housing can be successful in communities that have ample rental housing stock in standard condition. In many communities, however, there are not a sufficient number of units that are both standard and reasonably priced for purchase. For this reason, it may not be cost effective to purchase existing units and offer them at an affordable rent.

Both CDBG and HOME funds can be used to acquire existing rental housing. For HOME, the developer needs to keep in mind the requirement that the units meet the applicable local code or national model codes and standards. If the units are not standard, HOME can also assist with rehabilitation costs (see below). Under CDBG, acquisition is an eligible activity, provided it meets a national objective. Acquiring rental units for occupancy by low- and moderate-income tenants would be eligible as a low- and moderate-income housing activity. Rental housing acquisition funded with CDBG would need to be undertaken by the grantee, a public agency, or a nonprofit organization because CDBG prohibits acquisition-only housing activities to be conducted by for-profit entities. In addition, CDBG permits for-profit entities to undertake acquisition with rehabilitation because that is classified as a rehabilitation activity rather than as an acquisition activity.

Tenant-Based Rental Assistance

Another method of making existing rental housing affordable is to offer assistance to tenants to help them afford their rent. The most common tenant-based rental assistance (TBRA) model is the Housing Choice Voucher Program that is run by housing authorities across the country. Under this program, a household chooses a standard unit and the housing authority subsidizes the difference between what the household can afford to pay, and a fixed rent ceiling known as a payment standard. The household then makes up the difference between the actual rent and the housing authority subsidy.

The benefit of this approach is that it is flexible and allows the household to choose where they want to live. Also, TBRA programs can be much more cost effective than rental development programs. For example:

TBRA Cost Effectiveness

Assume that it costs $150,000 per unit to build a new rental unit and the jurisdiction wants to create 50 affordable rental units. That is a total development cost of $7,500,000. Assume the project is funded completely with various forms of public subsidy and that the project has an affordability period of 20 years.

Compare this to a TBRA program in the same community. It has a payment standard of $800 based on the FMR. Thirty (30) percent of the income of a household at 60 percent of median income is $600. So the jurisdiction -- in general—will make up $200 per unit per month in TBRA costs or $2,400 per year.

So, the jurisdiction can subsidize 156 families for 20 years using TBRA for $7,500,000, or, for the same amount, it can develop 50 units of affordable housing for 20 years. Even if the public subsidy is only half of the development cost, the jurisdiction could still fund 28 more families using TBRA.

TBRA may not work in all market conditions, however. First, it is only effective in communities where there exists a supply of standard affordable housing. In many jurisdictions, there are no available units where households could use their TBRA. In addition, TBRA does not permanently increase the supply of affordable housing within the community. If HOME funding is reduced and the jurisdiction has no other funding source, or the funding priorities change, there is no lasting effect on the housing supply.

HOME can be used to create a TBRA program. The program options are highly flexible—from a Housing Choice Voucher model to a security deposit only program. However, it should be noted that the costs to administer a HOME TBRA program cannot be charged as a project cost and must be paid out of the PJ’s administrative budget, and subject to its 10 percent cap.

CDBG cannot be used for TBRA because the CDBG program considers rental assistance as a type of income payment (i.e., payments directly to or on behalf of households) which is expressly prohibited, unless it is conducted as a part of a CBDO eligible activity. However, the CDBG regulations at 24 CFR 570.201(k) and the statute at 105(a)(20) allow CDBG funds to be used to administer HOME TBRA programs (as well as provide other HOME-related housing services). This is important because it is a separately eligible CDBG activity that is not subject to the CDBG administrative cap. So, although CDBG cannot directly fund TBRA, it could support the operation of such a program, and this might be a good opportunity for combining the two funding sources.

In some programs, rental assistance is provided as project-based assistance, where a public entity provides an owner with ongoing assistance to cover his or her operating costs in return for reduced rents. Unlike TBRA, project-based assistance is tied to a unit and does not move with the tenant. Neither HOME nor CDBG can be used for project-based assistance.

Rehabilitation

Rehabilitation of existing housing is another way of creating affordable, standard rental housing. Under this model, a jurisdiction provides low-cost assistance to help an owner bring his or her units up to a quality standard. In return, the owner agrees to rent units at reduced rents to low-income households.

This model can be combined with acquisition so that the developer is acquiring and rehabilitating the property. Rehabilitation can be minimal, or it can sometimes be very extensive, including reconstruction.

The obvious benefit of this approach is that it not only helps to house low-income families but it reduces the number of existing dilapidated housing units in the community.

This approach to developing affordable rental housing can be quite expensive, however. In some communities, and given some project situations, it can be more expensive to renovate units than to undertake new construction. Also, when rehabilitating occupied units, extensive renovations might cause displacement and trigger requirements and related costs under the Uniform Relocation Act and/or Section 104(d) relocation requirements.

Both HOME and CDBG can be used for rehabilitation only and for acquisition with rehabilitation. HOME requires that all assisted units be rehabilitated in accordance with a minimum property standard, but CDBG does not. Under CDBG, the developer can fix the most critical items (such as emergency repairs of major systems) but it would not necessarily be required to bring the entire unit up to housing codes and standards.

In addition, both programs can be used for historic preservation as a part of rehabilitation. In these instances, jurisdictions will want to work with their State’s Historic Preservation Office (SHPO) to determine the appropriate scope of work.

 

Example: Acquisition with Rehabilitation

The town of Eastbrooke has a large number of dilapidated rental structures. The cost to renovate these structures exceeds the likely return to any developer. So, they remain vacant and an eyesore for the community. Meanwhile, the waiting list for the jurisdiction’s rental program is years long.

So, Eastbrooke creates a program where it will provide assistance to CHDOs to buy, renovate, and manage rental properties. The HOME assistance will be used for acquisition and for extensive rehabilitation and is structured as a 0% interest rate loan. CHDOs can borrow HOME funds up to 40 percent of the unit’s total development cost. The remainder of the funds comes from low-income housing tax credits (LIHTC) and private loans.

The reduced rate HOME financing allows the CHDO to cover its development costs and offer units that rent below the HOME (and LIHTC) rent limits.

 

New Construction

Jurisdictions can provide affordable rental housing by building new units. Under this approach, the jurisdiction typically works with a nonprofit or for-profit developer who identifies the site, develops the plans and specifications, and works with a general contractor to build the units.

The benefit of new construction is that it generates new affordable units for the community. In addition to creating housing, new units can help spur development of other units and services in the neighborhood.

New construction can also be very expensive, and delivery of the new units can take a long time.

HOME can be used for new construction of rental units. It can finance all or a portion of the costs, including the acquisition of the site, hard construction costs, soft costs or an 18-month project operating reserve. As with other forms of rental development, the amount of HOME funds invested will dictate how many HOME units must be provided.

CDBG cannot be used to pay for the hard costs or the soft costs of new construction unless the construction is being undertaken by a CBDO as a part of a neighborhood revitalization, energy conservation, or community economic development activity. A common misconception is that CDBG funds can be used for soft costs for new construction (such as architect’s fees, building permits, engineering etc.). These costs are generally not allowed because they are not a separately eligible activity unto themselves—they are necessarily related to the new construction, which is not generally eligible under CDBG.

The Entitlement CDBG program regulations contain limitations on the use of CDBG funds for "soft costs" related to new housing construction. The Housing and Community Development Act (HCDA) only lists activities that are eligible for CDBG funding, and so has no discussion of new housing construction. Under the State CDBG program regulations, states are given the ability to interpret the list of eligible activities in the HCDA, providing their interpretations are not plainly inconsistent with the HCDA. States may use the Entitlement program eligibility regulations as interpretive guidance.

CDBG can be used to support the development of new construction by financing the cost of activities that are separately eligible activities, such as site clearance or demolition. In addition, CDBG can be used for any infrastructure that is owned by a public or nonprofit agency. CDBG can also be used for property acquisition when it is undertaken by the grantee, a public agency, or a nonprofit.

 

Example: New Construction

The town of Glendale needs more rental housing units for its very low-income elderly residents. However, none of the buildings in its community are fully adapted for the special needs of these elderly residents (such as wheelchair accessible bathrooms, adapted kitchens, live-in nursing aide quarters, etc.)

So, the PJ worked with a local faith-based nonprofit to acquire land and build a new 30 unit building for very low-income seniors. The PJ provided the nonprofit with a deferred payment HOME loan due only upon sale of the property. The remainder of the development financing came from state and foundation grants. The nonprofit conducted fundraising among the congregation members and the community at-large in order to raise funds for ongoing property operation and maintenance.

 

A jurisdiction might also rehabilitate an existing building and convert it into affordable units. This is known as "conversion" and it is treated as rehabilitation under HOME.iii

Conversion of existing non-housing structures to new housing is permitted under CDBG. For example, a grantee could use CDBG funds to convert an old, abandoned school into affordable housing. CDBG treats the conversion of a non-residential building to a residential use as rehabilitation.

Example: Conversion

The town of Lakeside has an old hotel that is dilapidated and boarded up. It also has a severe shortage of affordable rental units.

A for-profit developer wants to buy and convert the hotel into apartments. They want to have up-scale loft style apartments on the top floor. However, in return for HOME assistance, they agree to allow for 40% of the total units to be occupied by low-income households.

Lakeside determines how much HOME money they can provide given the costs of the affordable units and provides that assistance as a 2% interest rate loan where payments will not start until the 3rd year of the affordability period. This delayed start time allows the owner to build a market for the units and stabilize the project’s income and operating expenses.



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